What is Yield Management? History, Formulas and More!
Yield management is a fundamental concept for profitable hotel management. You can think of it like the grandfather of modern revenue management, as it was one of the earliest techniques for maximizing a hotel’s revenue. Today, it continues to play a big role in how revenue management systems like Pace deliver results for hotels.
Yield management involves the use of dynamic pricing to control profitability around fixed inventory supply. The term was actually pioneered by the airline industry in the 1980s before being brought into the hotel industry to price hotel rooms since hotel rooms are somewhat more of a complicated problem to solve. While flexing supply and pricing are still the fundamental activities of modern revenue management, the field has become significantly more sophisticated in the last three decades as hotels (and all businesses for that matter) have gained access to new data sets.
For example, when yield management was first pioneered, hotels were less focused on maximum guest value or tRevPAR. tRevPAR stands for "total revenue per available room" which includes ancillaries like F&B, spa, amenities, etc. Modern revenue management involves pricing based on this total expected spend which is an illustration of how we've evolved from purely yield management into total revenue management.
Yield management is still highly relevant in today's business world; however, it's just one piece of the puzzle rather than the entire puzzle like it was decades ago. Before diving into the cutting edge technical new innovations in revenue management it's critical to first understand the basics of yield management. Here’s a crash course on what it is and why it matters for your hotel.
What is Yield Management?
In the general business sense, yield is another word for profit. It’s the amount of income left over after paying out all the expenses related to running your business. In the case of yield management for hotels, it refers to strategically setting rates to optimize room revenues (pricing) and occupancy (bookings volume). In the hospitality industry, we ultimately want to leverage yield management systems and a variable pricing strategy to deliver different prices to different customers in the pursuit of maximizing "yield" or revenue. Hotel revenue management strategies vary depending upon the number of rooms in a hotel.
As a subset of revenue management, yield management focuses exclusively on finding your hotel’s optimal balance of supply and demand for its rooms, or the point where prices perfectly match traveler demand. That’s the point where your rates will “yield” the highest number of bookings at the highest possible price. Before hotel professionals had access to rich consumer and travel data, yield management was the industry’s first foray into revenue management.
“Whereas revenue management involves predicting consumer behavior by segmenting markets, forecasting demand, and optimizing prices for several different types of products, yield management refers specifically to maximizing revenue through inventory control.” ~Livio Moretti, Distribution Strategy
Yield management is a tug-of-war of sorts between price and quantity. Set your rates too high, demand drops, bookings slow, and occupancy sinks. Set your rates too low and you sacrifice revenue for volume, potentially pushing demand beyond your ability to supply it -- that’s a bad place to be, as it not only pushes demand to your competitors but also increases the strain on your staff, potentially increasing expenses and further depressing profitability. Of course, supply and demand are never perfectly aligned. And it’s not a simple task to pursue that balance and stay on target. But the upside of greater revenues is worth it!
Importance of Yield Management
The top advantage of yield management is that it efficiently harnesses demand. It ensures that hoteliers are making the most money possible from their asset. With high fixed costs, hotels need to yield the most revenue possible from those fixed costs. Hotels also need to yield the most revenue from existing demand to be as efficient as possible with related distribution and marketing expenses.
Yield management is also a critical piece of profitability. If revenue goes up, and expenses are fixed, there’s a significant impact on profitability, as that additional revenue is nearly pure profit. On the flip side, if revenue drops and expenses stay the same, there’s a deterioration in profit. In a dynamic business like hotels, sudden dips in demand can quickly put hotels (especially independents and smaller brands) into crisis mode. Yield management shields somewhat from that downside and helps maximize the upside, all by more effectively managing existing demand.
A third advantage of yield management is that it’s a targeted task that doesn't take a village to accomplish. So, while you could also maximize yield (ie. profitability) by working with operations to reduce expenses or working with revenue management, marketing, and sales to increase revenues from room and non-room sources, yield management is more straightforward. It’s all about the data and, with a great revenue management system like Pace, the process can be put on autopilot with minimal intervention. Yield management software is low-barrier and high-impact -- it really doesn’t get much better than that!
Yield Management Formula
The basic way to calculate yield is to quite literally calculate how much revenue you left on the table. A simple formula to calculate yield is: Revenue Achieved / Maximum Potential Revenue.
Let's say your hotel has 50 all-suite rooms, with a rack rate of $350 each. That means that your total potential revenue is $17,500 ($350 rate multiplied by 50 rooms). Last night, you sold 25 rooms at $200 each, grossing $5,000. Your yield is then $5,000 divided by $17,500, or 28.5%. That yield may be concerning, but it doesn't tell the whole picture.
Each yield must be compared to the bigger picture, such as your compset’s performance for the same date. And, yield management is generally done in advance, so that rates can be adjusted in real-time to account for advance booking trends. For instance, if you see a sustained spike in last-minute bookings at higher rates, you may want to consider increasing rates for future dates to further sustain those high-yield last-minute bookings.
To capture the most bookings possible at the best possible rates, you’ll need a clear view into the factors that impact demand (and thus your hotel’s optimal rates). Some of the factors that influence yield management include:
Booking windows affect demand, especially when it comes to price sensitivity. Compressed booking windows have “created a fast-paced dynamic environment.”
Market-level dynamics. Is your market losing out to nearby destinations? Are there large events in town causing compression? Is local hotel supply shrinking or expanding? Are there shifting traveler trends affecting your market?
Compset positioning, or the way potential guests perceive your hotel when compared to the other hotels under consideration. Perceived value within a compset plays a big role in your hotel’s demand.
Macroeconomic conditions shape demand locally. A recession requires different yield management strategies then periods of growth. For hotels with many international guests, conditions elsewhere can dampen or boost demand.
Historical performance provide insights into future demand forecasts at the property level.
Segments, such as leisure, business, and group, each have their own demand curves, and factor into your hotel’s overall business mix.
The time of year is a major component in demand for most hotels.
The next step is to take all of this information and translate into a full yield management strategy.
How to do Yield Management
There are two ways to manage a hotel’s yield: manual or automated. To manage yields manually, this is generally how it’s done:
Pull rates and availability data from your PMS.
Pull competitor data from individual OTA channels or rate intelligence tools.
Combine the data sets into a single spreadsheet, align dates, and set up custom formulas to calculate key ratios.
Enable conditional formatting to highlight high/low trends so you can quickly see areas of concern.
Manually adjust rates in the spreadsheet and then upload it to PMS/OTA for onward distribution.
For some, this hands-on process is part of staying close to the property. For most, however, the process is too intimidating and/or time-intensive to do regularly. Technology can help reduce the burden of manually responding to fluctuations in demand by constantly analyzing data and adjusting rates accordingly.
Revenue management software, such as Pace, automatically pull in relevant data sources and deploy machine learning to forecast future demand by identifying patterns in historical demand at both the property- and market-level. These forecasts become the basis for rate recommendations, which can be automatically applied in real-time to keep inventory priced optimally 24/7. While some think that automated revenue management software will put revenue managers and yield managers out of work, most in the technology community believe that effective yield management in the future will be part man and part machine. In other words we will always need revenue managers to maximize ADR & RevPAR and identify attractive market segments to drive strategic decisions; however, the daily tasks of those professionals will continue to evolve with more sophisticated technology tools.
Pace’s easy-to-use tools make it simple to stay on top of pricing decisions.
A caution to those that prefer the hands-on approach: As revenue management tools have dropped in price, they’ve become more accessible to hotels of all sizes and geographies. It's harder and harder to compete against other hotels using machines to optimize their yields. Those tools are speedy, accurate, and always-on whereas manual updates can lag behind and put your hotel at a competitive disadvantage. When considering adding revenue management technology, know that you can turn off total automation and review all rate suggestions prior to onwards distribution. That way you can still keep your pulse on the rates while staying competitive thanks to data-driven intelligent pricing.
Extra Credit: A Note on Price Elasticity and Perceived Value
One of the features of supply and demand is the concept of price elasticity, or the idea that different demographics may respond unexpectedly to prices. It’s the consumer’s “willingness to pay,” which doesn't always correlate nicely with classic supply and demand thinking, where higher prices reduce demand. Price elasticity can influence room rates as it’s about the perceived value of the goods being purchased. That’s why luxury hotels can keep supply low and prices high without necessarily dampening demand.
Even so, perceived value is hard to measure and won't show up in the data (at least not in a way that makes it easy to identify the role perceived value plays in how a consumer chooses to buy). And the reality of today’s industry is that travelers have more ways to stay than ever before. With the rise of alternative lodging, travelers can consider a wider array of options to find the price and product that suits their specific needs. Since consumers can easily substitute similar room types, amenities, and properties, there’s greater price elasticity. It's easier to get what they want without paying more than they want.
Greater choice means more competition and pressure to price properly. More so than ever, hotels must put the right price in front of the right customer on the right channel at the right time -- not to mention market their property with visuals and words that converts lookers to bookers.